Some of the things that catches my attention with frauds and Ponzi schemes are the steps that the fraudsters will take to cover up the fraud and how they think they will escape from the fraud unscathed. The recent charges against Jeremy Drake caught my attention because of the steps he took.
The Securities and Exchange Commission has filed the charges, but Mr. Drake has not yet had a chance to refute them. I’m just using the allegations as a way to help me (and maybe you) better understand how frauds evolve.
According to the complaint, Mr. Drake worked as a registered investment adviser representative. He managed to convince a professional athlete and his wife to become his clients. (I poked around, but couldn’t find out who.) The relationship started off with a standard 1% fee.
In 2012 Mr. Drake told them they were entitled to a VIP discount on the fee. I assume (1) his clients pressed him on fees, (2) his firm did not agree to the discount, and (3) Drake lied to keep them as clients. He fed them some gobbledygook about how they were getting credits in their account from the brokerage. I can only assume that he thought he could eventually convince his firm to give the discount.
But there was no discount. The client met with Mr. Drake a year later and he once again spewed out the discounted rate. He documented the fraud by sending fake account statements stating that the clients had paid “net” rates of 0.177% and 0.15%, resulting in “net” fees of $44,994 and $34,737. They had in fact paid a 1.0% rate in both accounts, resulting in actual fees paid of $280,349 and $231,889.
At this point, you may expect that the firm could have spotted Mr. Drake’s fraud. The rep is sending the account statements instead of them coming from the custodian.
A year later, the same discussion over fees happened again and more fake documents were sent. The client’s wife first language was not English, so perhaps Mr. Drake thought he could use the language barrier to keep the fraud going. The client’s wife’s assistant was the translator.
In 2016 with a new assistant and a new accountant, the client pressed Drake again. Drake continued with the lies and fake documents. The fraud was not holding together and they pressed Drake on the fee discount. To bolster the fraud, Drake created a false persona named “Ron Stenson” whom he held out as an employee of “Charles Schwab Advisor Services” who could help explain the fee credit. He pressed a colleague into the role of Ron Stenson to answer phone call inquiries.
At this point Mr. Drake realized he couldn’t keep the fraud going. The accounts were short almost a million dollars in the fees the firm was taking compared to what he was telling the clients. I scratch my head wondering how Mr. Drake was going to get out of this. I have to assume that he hoped the firm was going to grant the discount at some point.
Should Mr. Drake’s firm caught some of this activity through email monitoring? Maybe. I’m skeptical of the effectiveness of email monitoring. It’s full of false positives, causing compliance to stare at a lot of stuff instead of spending time looking at other areas.
Theoretically, Mr. Drake’s clients should have been getting account statements directly from the third-party custodian. That should have shown actual fees deducted and the actual positions held by the client. That is one of the key pillars of the custody rule. The client should be able to verify an advisor’s work by getting the account statement directly from the custodian or getting statements that have been vetted through a third-party auditor.